Investors wary of Frontier litigation risk

5 min read
Americas
David Bell

After the bankruptcy filing of Windstream last month, some junk investors are wary of Frontier Communications’ debt on concerns the company could be vulnerable to potential legal risk over its debt covenants.

The remaining US$348m of its 7.125% 2019 senior unsecured bonds mature this Friday and the company said on its earnings call on February 26 it expects to repay them in full.

The company had US$354m of cash and equivalents on its balance sheet at the end of 2018 and had drawn US$275m on its US$850m revolving credit facility, according to its full year earnings report.

“We have ample liquidity to meet those obligations including full access to our US$850m revolver,” said Sheldon Bruha, interim CFO and treasurer, on the earnings call.

But some said that capacity on the revolver could face limitations because of legacy bond covenants.

Analysts at JP Morgan said that because of a negative pledge covenant on the company’s legacy bonds, it’s possible only an estimated US$500m would be available.

Negative pledge covenants restrict how much debt can be incurred against the firm’s assets.

“So if the company believes it has the full US$850m available, it is likely doing so on the basis of covenant carveouts that could be disputed,” wrote JP Morgan credit analyst Thomas Egan on March 1.

Frontier did not respond for a request for comment on its plans to repay the March 2019 debt, or how much capacity it could access under its revolver.

LEGAL RISKS

The Windstream case showed that legal disputes over covenant breaches can turn ugly and costly.

The company was forced into bankruptcy after a legal case brought by an activist hedge fund, Aurelius Capital, which argued successfully that the company had technically defaulted on its bonds in 2015.

Against that backdrop, investors are now becoming increasingly wary of situations where similar legal tactics could be employed.

“It’s not wildly unlike Windstream. Some counterparties are not linked up on what the potential capacity is,” said one portfolio manager.

“It’s an appealing looking structure, but there’s just too much litigation risk,” he said.

“There are some incredibly litigious counterparties, and when you have a feeling the decision is going to be decided in the courts, and not by the fundamentals of the business, that’s a situation to avoid.”

Another high yield credit analyst said, “It will come down to a language interpretation.”

“I think they’re probably fine, but who knows. There’s a lot of concern about the sector in general, and after Windstream, people are definitely looking at this with a skeptical eye.”

The Windstream case and others, such as with homebuilder Hovnanian, have drawn attention to the role played by activist debt investors, particularly over the use of credit default swaps.

Some have argued that the derivative instruments, which pay out in the event of default, create opportunities for firms to push companies into so-called “manufactured defaults” that can benefit activists at the expense of ordinary bondholders.

Regulatory board ISDA proposed last week that CDS should only pay out if a default is linked to a decline in creditworthiness of the borrower, in an attempt to clean up the market and ensure that CDS prices remain a close reflection of credit quality.

FRONTIER HEALTH

Aside from the legal risk, analysts are also skeptical about Frontier’s business and financial outlook.

The company has over US$16bn of long term debt and expects to generate between US$575m-US$675m in free cashflow in 2019.

S&P said in a report that it was “highly” uncertain the company would be able to address the US$2.7bn of debt falling due in 2022 because of its lack of secured debt capacity, low operating free cash flow and high leverage.

Frontier has taken several steps over the last quarter to tackle its US$16bn debt load including repaying its outstanding 8.125% unsecured notes last October and purchasing US$56m of its outstanding 7.125% 2019 unsecured bonds in the fourth quarter, when the bonds dipped below par to around 94.

It sold a US$1.65bn eight-year non-call three senior secured note on Tuesday to refinance a secured term loan facility and a credit facility with CoBank ACB that matures in March 2021.

The new B2/B rated debt was priced at 8%, in line with price talk, with JP Morgan the lead bank.

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